Standard & Poor’s release their Australian Banking Outlook for 2016

Standard & Poor’s (S&P) released their 2016 outlook on the Australian banking sector on the 21st February 2016.   In summary:

• S&P views Australia as remaining amongst the lowest-risk banking systems globally;
• S&P’s senior credit rating for the four major Australian banks would come under pressure if the move to establish a framework for the bail-in of banks’ senior debt or additional loss absorbing capital gathers momentum (Canadian banks suffered a credit rating downgrade for this reason during 2014 & 2015) as Basel IV capital frameworks are agreed upon;
• However, the major Australian banks’ stand-alone credit profiles (SACPs) would strengthen if clarity emerges that an increase in regulatory capital requirements would push S&P’s risk-adjusted capital (RAC) ratios above 10%. As of 30th September 2015 all four major banks’ RAC were below 9% with the S&P forecast placing all four major banks within the 8.0% to 9.5% RAC range during 2016;
• S&P expect to raise their credit ratings on bank hybrid and subordinate instruments in such a scenario (as their ratings on these instruments are based on a bank’s SACP);
• Finally, S&P considers the probability that the banks redefine their core focus areas as a result of further increases to regulatory capital requirements as low, i.e. S&P believes that the banks will not be exiting business segments such as life insurance and superannuation funds management that are currently considered core operations.

  S&P’s base case is for Australian housing is for further increases in house prices to be more measured, reducing the risk of a disorderly unwinding of property prices. S&P acknowledge that if this view proves incorrect, then all banks operating within Australia would face increased economic risks that could in turn place downwards pressure on the SACPs of all banks in Australia. S&P did take into account the regulatory changes relating to residential mortgage lending during 2015 nor have they taken into account any discussions by the two major political parties regarding potential changes to negative gearing and/or capital gains tax as these changes are purely speculative at this stage.   S&P’s view on non core asset disposals may be a little conservative considering the NAB have sold 80% of the MLC Life business to Nippon Life and are possibly looking to divest the MLC funds management business, the ANZ have have been reported to be reassessing their commitment to the minority owned Asian business’, Oasis platform and potentially the One Path business’, Westpac last year reduced their stake in BT Funds business and the CBA announced the Goldman Sachs institutional equity research joint venture.   More supply of hybrid capital over the short to medium term is a reality under the scenario above although it should be noted that the bulk of capital raised by the banks is expected to be via non-core asset disposals and common equity raisings (via a combination of retaining earnings or by going to the equity market directly). Either way this should eventuate in an increased level of capital support for all obligors that sit above common equity (including hybrids) in the bank’s capital structure. Due to dividend stopper provisions being part of the terms an conditions embedded in hybrid documents, any fall in earnings for the banks should be borne more heavily by the common equity investor than the hybrid investor.